[Whitepaper v1] – Yield Market System for Pegged Block-chain Currencies

[starspirit]

In the absence of a plan on how to implement endogenous feeds, I think we need to accept the critical role of the price feed, and expend considerable effort in making the price feeds as reliable as possible. If a plan comes along one day, and stacks up, then I hope it will be possible to make a transition from any system.

The problem with this assumption is that it may not hold. As the liquidity in the internal markets increase, you could easily imagine a situation where the vast majority of trading volume was taking place on the internal exchange (at least in some markets) and as such the feed price would be almost completely controlled by the internal pricing.

Any new system design should at least be able to operate consistently under such constraints, IMO.

You're right, it may not hold. But I'll have to explore this further by opening a new thread for it. I'm really not getting the entire concept of endogenous price feeds.


Edited Update: OK, so to summarise, we explored the concept of endogenous price feeds in a separate thread here...https://bitsharestalk.org/index.php/topic,15903.0.html
For now I'm not convinced of the possibility of an endogenous price feed, nor the need to have a transition plan for one, so I don't want to get further distracted down this path for now. For me, the possibility of manipulation of the feed price is probably a deeper issue to resolve for pegged currencies in general.

[monsterer]

In the absence of a plan on how to implement endogenous feeds, I think we need to accept the critical role of the price feed, and expend considerable effort in making the price feeds as reliable as possible. If a plan comes along one day, and stacks up, then I hope it will be possible to make a transition from any system.

The problem with this assumption is that it may not hold. As the liquidity in the internal markets increase, you could easily imagine a situation where the vast majority of trading volume was taking place on the internal exchange (at least in some markets) and as such the feed price would be almost completely controlled by the internal pricing.

Any new system design should at least be able to operate consistently under such constraints, IMO.

[starspirit]

NOTE: I may update this whitepaper shortly to accommodate this...https://bitsharestalk.org/index.php/topic,15775.msg203954.html#msg203954
...depending on further analysis of that approach.

[I've also just added an important note to the OP on the bill market]

[starspirit]

How does this system transition in the as the feed price starts out entirely exogenous and tends toward entirely endogenous as market liquidity increases? i.e can it cope with a environment where the feed price is dominated by internal market forces?

Monsterer, good question, but do we even know that endogenous price feeds are possible? To believe this is more than just BitShares folklore, somebody needs to put forward for review a coherent plan for the mechanics of such a system, and then show how it would apply to the proposed BitAsset 3.0, which on reflection is just as reliant on the price feed as the Market Yield System.

To clarify, in the Yield Market System, all new currency creation and destruction in the Currency Creation Market is exposed to the reliability of the price feed, while free transactions in any other bitCurrency markets (potentially including a freely traded bitCurrency to BTS market on the internal exchange) have no such feed price constraints. In BitAsset 3.0, on the surface it seems basically equivalent to me - all currency destruction is also reliant on the feed price, and this also effectively sets the price constraints on new currency creation. Without a reliable feed price, this would also undermine the viability of BitAsset 3.0, as neither longs nor shorts could trust the settlement process, which would affect pricing and activity throughout the system.

In the absence of a plan on how to implement endogenous feeds, I think we need to accept the critical role of the price feed, and expend considerable effort in making the price feeds as reliable as possible. If a plan comes along one day, and stacks up, then I hope it will be possible to make a transition from any system.

[monsterer]

How does this system transition in the as the feed price starts out entirely exogenous and tends toward entirely endogenous as market liquidity increases? i.e can it cope with a environment where the feed price is dominated by internal market forces?

[starspirit]

4. Implementation and Practical Considerations

The Need for a Reliable Price Feed

As all transactions in the Currency Creation Market occur at the Feed Price, and convertibility to currency underpins valuation in the Bill Market, it is critical to have a reliable price feed.

If the price feed at any time was generally considered by users to be below fair value, this would increase demand, reduce supply, and force down interest rates to restore a balance of supply and demand. Conversely, if the price feed were expensive, demand would fall, sellers rise, and shorts compete to lift interest rates to avoid getting closed out. This would increase rates.

Although interest rate variation allows the market to clear in such circumstances, an unreliable price feed would introduce additional volatility into the interest rate, and reduce activity in the market. Users would ultimately demand far greater reliability.

Finding the right solution is a pragmatic matter for the community at large, and may evolve with the maturity of the system. Some possible forms are:

i)   appoint a trusted provider from within the community
ii)   contract a select group of trusted external providers
iii)   incentivize a decentralized free market of providers.

[start edit Apr 27]

A further important issue is potential manipulation of feed prices by counter-parties forcing the price of the native token in illiquid external markets to their favour.

One way the Bitshares community has sought to resolve this is with a time lag between trade request and settlement, so that potential aberrant price behavior can be detected and potentially exploited in advance. It may be possible to introduce such a lag (eg 24 hours) into the Currency Creation Market, but this may create lags in settlement of Bill Market transactions and expiries. The full consequences would require further exploration.

Another option may be to ensure the collateral market is as liquid as possible – see Collateralisation -  Possibility of using a collateral token other than the native token.

[end edit Apr 27]

The Zero Interest Bound Problem in the Currency Creation Market

There are a number of conceivable situations where negative rates are required to clear the market. There may be financial repression in the fiat currency being pegged, extreme bearishness on the native token amongst potential shorts, or an insufficient supply of native tokens from which to create new currency. If the market is unable to clear, a shortage results and owners hoard the currency.

Negative rates are easily accommodated in the Bill Market, as price can move above par to achieve this.

The Currency Creation Market is more challenging because actual interest transfers need to take place between parties.

Two possible approaches to clear the market are as follows:

i)   Allow negative interest rates and transfers from longs to shorts if necessary
ii)   At the zero-bound, allow price to move above the feed price.

Regarding (i), it may be technically impossible to force owners to make interest payments from their own wallets. A way around this might be to force all currency to be kept in a joint account on the block-chain, with users holding a share of that account, rather than currency directly. The account could make interest payments to shorts. A form of check-based payment system would need to be established to allow account holders to make and receive payments in units of the currency.

Regarding (ii), buyers, sellers and shorts would specify orders in one of two forms - either a positive interest rate, or a price relative to the feed price (in the form FP+X%) with 0% interest. The ranking of the buy and sell side of the market is then co-linear, based only on the premium X% at 0% interest, and interest rate above 0% interest. A side-effect of this is that a premium in external markets could not be arbitraged away if there were a premium in the internal market. There may also be ripple effects on other rules in the system that need to be considered.

[start edit 27 April]

Bill Market Structure

The simplest form of Bill Market is actually to have one exchanged and settled in native tokens like the Currency Creation Market. The price feed would determine par value, and exchange prices relative to par would determine the yield to expiry. Such an approach would still retain all the benefits of the Yield Market System, but be less convenient and more risky for users as they would be forced to use the native token for any switching between currencies and bills, and reinvestments at expiries.

Allowing the Bill Market to be exchanged and settled in currency tokens makes a much cleaner experience for users, who may never have to touch the native token at all. The effect of this though, is that a two-step process is required to ensure bill shorts get leverage to the native token. An extra step is required for currency tokens to be automatically converted to native tokens, and visa versa on margin calls.

In theory, if the short did not demand instant leverage, there is in fact no reason why the currency tokens could not be retained indefinitely in collateral. This is suggestive of an even more flexible system for shorts – see Potential for Flexible Collateral below.

BitAsset 3.0 and the Possibility of Non-Interest Bearing Cash

The recently proposed BitAsset 3.0 structure introduces the idea of non-interest bearing cash tokens. This section explores the merit of such a token and how it might be facilitated in the Market Yield System.

For such cash to find use in transactions, it would be important that it not get hoarded in the bond market to earn a yield. Particularly when interest rates are high, this would almost certainly require an interest-bearing at-call deposit market so that cash is able to move freely.

One possible advantage of separating cash from at-call deposits could be that the at-call deposit market could be set up as block-chain based accounts that allow negative interest rates when necessary to clear the market. See The Zero Interest Bound Problem in The Currency Creation Market. However, it may not be necessary to have a separate cash market to accommodate this – the cash units could be purely notional and only ever exist inside the accounts. And allowing exchange above the feed price is an alternate market clearing solution to allowing negative interest rates.

It is possible there are other reasons why users may choose at times to prefer non-interest cash to interest bearing deposits. These reasons would need to be made clear the justify the existence of a separate cash market. Possibilities might include increased privacy or anonymity, increased security/collateralization, or the ability to offer some cash-based services without the complication of dealing with interest payments on behalf of clients.

Regarding facilitation, this might be done as follows, although further thought is required on this:

(i) A Cash Creation Market with a cash token settled in the native token as per BitAsset 3.0 or some variation
(ii) A Deposit Market with a deposit token settled in the cash token, that can earn at-call interest (this would use the mechanics described for the Currency Creation Market)
(iii)   A Bill Market with bill tokens also settled in cash tokens. Any shorts at expiry that did not meet the minimum collateral requirement for the Cash Creation Market, would be called immediately in that market

[End edit 27 Apr]

Collateralisation

All currency and bill tokens must be collateralized by the native token to eliminate counterparty risk.

The key risk for currency and bill owners is that the value of pool collateral falls below the total value of the currency and bill tokens on issue when evaluated at the feed price. This is labeled a black swan event, as the fall in value of collateral would have to be very swift to cause such an event. Unless corrected, this would leave some obligations unable to be met and devalue the tokens in the spot markets.

There are various feasible implementations for collateral that lead to different security outcomes for users. Ultimately this is a pragmatic implementation issue. Below are some possible approaches, subject to change, that need much more thorough analysis before being recommended. None of these approaches is necessarily critical to the Market Yield System described earlier in the whitepaper, and the core structure of the Market Yield System should not be judged on these detailed collateral considerations, which apply to any pegged currency system.

A single collateral pool for the system…

Users will tend to see the system as a whole. A single collateral pool for the entire system is probably best, as it is simpler for users to judge the collateral risk compared to separate pools for currency and bill tokens, and some pools (eg far-dated bill series) may have only a small number of open positions.

Seniority to currency and short dated tokens in black swan events…

A collateralization approach is possible where currency holders are senior to bills in black swan events, further increasing their security, and enhancing the perception of the currency in wider markets. We start with the observation that if the likelihood of a black swan event is seen by the market to have increased, currency and short dated bill holders are able to exit their positions more quickly, thereby causing a run on these tokens. Currency demand could be volatile as a result.

This behavior can be circumvented by offering the same priority should the black swan event occur. When the black swan event occurs, short-dated securities are treated as senior to long-dated securities, with long dated securities losing their capital first. This provides additional protection to currency holders, and requires long term lenders to demand more interest in compensation.

Black Swan IOUs…

In theory the lost capital of token holders in a black swan event, which for each token is only realized at its expiry, can be replaced by IOUs of some sort. There could be a method built into the system to take a slice of yields after such an event, to allocate toward repayment of IOUs. However, this would represent a cross-subsidisation of new users to old users, that would deter new users in any case from participating in the system.

It is better for the community or system stakeholders to determine what compensation if any may be appropriate, outside of the Market Yield System. Within the Market Yield System, this is simply a risk to be built into the market’s pricing.
Prior to expiries, it is possible for the system to self-correct, without IOUs being necessary. If not, sales of bill tokens will be at yields/prices that reflect the diminished value.

There is no reason why the markets cannot continue to function post such an event, albeit a change in the minimum collateral ratio might be called for. Change risk perceptions will simply be reflected in yields.

Minimum collateral ratio…

Shorts have a minimum collateral ratio to maintain, and could have the ability to increase or decrease collateral at any time as long as it remains above this. By cutting collateral too thin the short is at risk of call, and so an appropriate penalty should be attached to margin calls. On the whole shorts would seek to have an appropriate buffer to the minimum ratio.

The minimum collateral ratio could be periodically altered with enough notice, based on the co-volatility of the native token against the currency (ie. Volatility of the feed price), and the total pool collateral. Basically this metric would measure the current likelihood of existing collateral surplus being erased by a downward price move.

A trigger point to switch from interest to collateral prioritization on shorts

It may be enough to use the minimum collateral ratio as a lever to increase collateral when total pool collateral is low. In addition it may be possible to introduce a trigger point when prioritization of shorts across the entire system temporarily ranks on collateral rather than yield. When the danger is over, this could be renormalized. The details of such a mechanism are not covered here.

Combined Short Accounts…

Since users may have many shorts, spread across multiple tokens, it could be beneficial to treat each user on a holistic basis. That is, the collateral is pooled for all their shorts, and the collateral ratio based off their total short obligation. This negates the need to manage collateral for each short individually and risk being called on one short when collateral is available in others. The only requirement is that the Short Obligation, in being reset to different amounts and yields at any time, must still cumulatively add to the total currency short amount of the user. In the event of margin calls, there could be a prescribed sequence for covering token types, such as from far-dated to short-dated to currency, or a preferred sequence specified by the user.

Margin call losses can be subsidized by better collateralized accounts

Ultimately somebody must bear the loss of a margin call where remaining collateral is insufficient to buy back the obligation. This could be token holders, who would reflect that risk in higher rate demands, or other shorts, who would reflect that risk in lower rate offers.

If token holders were to cover the loss, to ensure that any currency token sales or bill expiries were made at a price equitable to remaining holders, they should receive an IOU as part of their payment. This would make the system unattractive, as there would always be IOUs floating around and confusing payments.

When the total collateral pool remains well enough collateralized, the most direct method to ensure that the loss is immediately covered is to remove a small portion of the native token from the collateral of remaining shorts. If the minimum collateral ratio is set appropriately, this loss risk should be very small in most circumstances.

The penalty applied on margin calls, where they are adequately collateralized to buy back the obligation, can be distributed to remaining shorts as a way of providing some symmetry around this risk.

[start edit 27 Apr]

Possibility of using a collateral token other than the native token

In principle it would be possible to use any token that exists on the same chain as the underlying collateral for the system. For example, as long as Bitcoin remains the dominant digital asset in the crypto-space, a token on the chain backed by real BTC off the chain could in theory be used, as long as users accepted the counterparty risks associated with that. This approach would allow the separation of the choice of the best collateral from the choice of the best system.

Potential for Flexible Collateral

In principle it is possible for shorts to meet their obligations through holding collateral in the form of native tokens, currency tokens, and bill tokens of the same or any shorter expiry. This suggests that a system of flexible collateral is possible, where shorts have full control over the form of the collateral held in their account, and are able to switch between these in the markets. This would allow shorts to adjust their leverage up or down as they please without having to change the number of their shorts. It would also allow them to take trading views or yield structure views in their short portfolio.

When a new bill short receives currency tokens, there is no need for the system to automatically exchange this for native tokens on their behalf, although they may still be able to set such an automatic option with their order if they prefer.

Margin calls would require the sale of any shorter-dated bill tokens in collateral, and then buyback of the obligation bill token second, in a two step process.

Expiries would not present any difference, as by that stage there are no shorter-dated bills remaining in collateral.

This is a much more sophisticated implementation approach that may be best considered for a future transition if desired.

[end edit 27 Apr]

Yield Vibration

Since yield accruals in the Currency Creation Market are determined by last price (consistent with bills, in fact, and necessary), this means that the accrual at any instant will be vibrating between the bid and ask in the market as orders transact. This will seem strange to users familiar with at-call deposit accounts.

It may be possible to present users with more meaningful metrics, such as:
-   current yield range X-Y% (bid-ask)
-   average yield last 24 hours, or average last week

It is however important that users understand the yield vibrates when they place limit orders in the market.

Setting Expiries

Expiries should be chosen to cater to distinctly different term preferences. For example, 1,3,6,12, and 24 months.

They would be set at common calendar points, such as month ends, and as each approach expiry, new series are periodically created to fill the gaps they left behind.


Limit Orders for Opening Shorts in the Currency Creation Market

Generally speaking short orders need to specify an interest rate somewhat higher than the current market rate to avoid being taken out soon after getting filled. This does not make it practical for users to set limit orders below market for opening shorts, which otherwise might be useful for some value-based strategies.

Two possible approaches to allow this are as follows:

i)   have the system alter the interest rate to some higher level as soon as a below market order is filled, or
ii)   allow a grace period before the Short Obligation (placing a bid in the market) takes effect

Regarding (i), the level would need to be a broadly acceptable premium to shorts so that do not end up paying a lot more interest than anticipated if the market rate moves suddenly. Having said that, they are able to then change the rate at any time.

Regarding (ii), once a short is opened (perhaps any short), there is a grace period (say 7 days) before an obligatory short cover order is placed in the buy queue. The purpose of the hold period is to give new shorts, especially those filled as a limit order, a chance to increase their interest rate if they like in case yields move higher in the interim. However this has a second order effect. Although unlikely, it’s conceivable that sellers could be larger than the buy queue, and result in a temporary surplus for the remaining holding period. As this is a short duration effect, it may not be necessary to try to prevent this, but allowing discounts to the price feed (FP-X%) in such a situation could be considered if necessary.

Yield Quotation

Yields could be quoted in terms of simple interest, discounts, or compound interest. It is important that the method used for interest rate payments in the Currency Creation Market is consistent with the way that yields are quoted by buyers and sellers in this market. Further, the way that yields are quoted for bids and orders in the Currency Creation Market should be consistent with the method used in the Bills Market so that there is consistency for comparison across the yield curve. The decision as to which method users would prefer is a pragmatic one outside the scope of this whitepaper.

Optional Tools for Users

Certain optional tools would allow greater usability.

Self-create
Self-creation is the ability, via a single operation, to establish both a long and a short position in a currency or bill token. As long as the self-creation order offers enough collateral, and sets an above-market interest rate for the Short Obligation in the case currency units, self-creation is possible without any adverse effect on the free market. While the user holds both the long and the short, this is an absolutely neutral position on both price and yield.

Self-cancel
Self-cancellation is the ability, via a single operation, to cancel a short position against a long holding of the same token. Again this has no impact on the free market.

Bill shorts meet redemption with currency
At expiry, shorts on bills naturally convert to shorts on currency, corresponding to the receipt of currency by the bill holder. However, the short may wish to hold no position beyond the expiry.

Of course they can self-cancel their position at any time through buying back the bill token. But equally they could be allowed to buy the par value of the bill in currency tokens, and deposit that in advance of satisfying redemption, which would negate the need to close early or close a subsequent currency short.

Lost wallets or keys

TBD

Winding up the System

TBD


*** END WHITEPAPER ***

[starspirit]

3. Beneficial Properties of the Yield Market System

Maximum Pegging in External Markets

The Yield Market System maximizes the price pegging of the currency token in external markets.

If there were a discount in external markets, arbitragers could buy the currency token in external markets and redeem it instantly for the native token in the Currency Creation Market.

If there were a premium in external markets, arbitragers could buy the currency token instantly for native tokens in the Currency Creation Market, and sell it in the external market.

Market-makers could self-create currency to sell into the external market for the underlying fiat currency when the currency token is at a premium, and reverse this by buying back the currency token to self-cancel their shorts when the external market was at a discount. These are neutral positions that result in spread profits over time.

Arbitrage and market-making activity of this nature would limit the gap to the peg price from moving much beyond the level of the transaction costs involved.

Yield arbitrage should also ensure that higher external yields on the underlying currency or its bond markets should be reflected in higher yields in the markets relating to the currency token. If external yields rose, there would be more incentive for users to create shorts and buy the underlying currency, pushing interest rates up. If external yields fell, there would be more incentive for users to buy currency and bill tokens, pushing yields down. However systemic risk factors may lead to a differential in interest rates that cannot be arbitraged risk-free, such as risks of black swan events in the native token.

Market Resilience to Supply-Demand Mismatches and Shocks

Through users having a choice of terms, supply-demand mismatches and shocks at any particular term can be absorbed across the yield structure, leading to more stable interest rates.

As an illustration, suppose that currency holders exhibited a strong preference for at-call holdings, and shorts exhibited a strong preference for 30 day exposures, likely a natural profile. If there were only an at-call market (such as the Currency Creation Market), interest rates would need to be very low to accommodate this preference mismatch. On the other hand, if there were only a 30 day market, interest rates would need to be very high to attract the necessary holders. If both markets existed, both shorts and longs would weigh up the opportunity costs of one market against the other. Some currency owners will elect to move to the 30 day market to take advantage of the higher yield, and some shorts will move to the at-call market to take advantage of the lower yield. This would ease the mismatch in both markets, and lead to some degree of convergence of those interest rates compared to where they would sit in isolation.

In a similar way, supply or demand shocks at any point on the yield curve will be distributed to some degree along the curve in both directions.

[starspirit]

2. General Architecture of the Yield Market System

Definitions

 “feed price” = the price at which the native token exchanges for the underlying currency in the external market, which is a necessary feed to the Yield Market System
“native token” = BTS
“currency token” = the pegged currency
“bill token” = a token that settles in the currency token at a specified future date

For clarity in this proposal, “greater than the feed price” means that more units of BTS are required per unit of the currency than at the feed price (FP), or that the asset is expensive, and “less than the feed price” means that less units of BTS are required per unit of the currency, or that the asset is cheap.


The Currency Creation Market

Essential properties

-   All exchanges, unit creation, and unit cancellations occur at the feed price
-   All demand for ownership of new units, or redemption of existing units, is met instantly, so there is no need for standard buys and sells to be queued or ranked. However, specification of a limit interest rate is used as a modifier of ownership demand.
-   The total demand at any time is continuously rationed among all potential shorts according to their required interest rate offers, which sit as an obligatory bid on the buy side of the market once a short is opened. Shorts fall out of the pool at any time there are more eager shorts offering a higher rate.
-   All shorts pay the same varying rate of interest to all longs, determined by the last matched interest rate in the market
-   All shorts are obligated to maintain a bid in the market at their interest offer. Not only does this allow more eager shorts to buy them out, it allows the supply to adjust instantly to changes in demand.
-   All purchases and sales of the currency are settled in the native token

The Currency Creation Market is the market in which currency units are created and destroyed, and is the only market within the system that requires a price feed. In fact, all transactions in this market occur at the price feed, and market exchange determines only the variable yield transferred from shorts to longs. As a result, a fair and reliable price feed is a paramount condition of the system.

Matching

The Currency Creation Market is made up of bids and offers for units of the currency, expressed only as an interest rate.  Bidders for the currency unit are queued from lowest interest rate to highest. Sellers of the currency unit are queued from highest interest rate to lowest.

The buy side consists of standard buy orders plus short cover orders (including the required bids of all shorts under the Short Obligation - below). The sell side consists of standard sell orders plus new short orders.

Currency supply is created when a standard buy order meets a new short order.  Currency supply is destroyed when a short cover order meets a standard sell order. Currency tokens change ownership when a standard buy order meets a standard sell order. Currency shorts change hands when a short cover order meets a new short order.

Currency Yield

The market rate of interest is driven upward by currency selling and short demand. It is driven downward by currency buying and short covers. The market rate of interest determines the yield paid jointly by the pool of shorts to the pool of longs.

Time is divided into windows, being the intervals between any two consecutive market trades. The yield that accrues to longs from shorts in any window is the agreed interest rate at which the last trade matched. There are practical issues at the zero interest bound that require some modification to clear this market – see Implementation and Practical Issues.

Short Obligation

The most important feature to underpin valuation within the entire currency system is the ability for any holder of the currency to instantly sell it for BTS at the price feed. An obligation by shorts to always have corresponding bids in the market for the full amount of their open positions means that any level of selling can be met at the price feed.

The Short Obligation compels shorts to consider the maximum interest rate at which they are willing to hold the short. When competing to open a new short, a user simply needs to offer more than the market rate. It is then filled to a limit of the interest rate specified in the order.

The interest rate limit on an open short, reflected as a bid in the market, can be altered up or down at any time. A user wishing to carry shorts indefinitely can aim to do so by maintaining a rate deep in the buy side queue.

Margin calls or other urgent covers necessitate the replacement of the bid interest rate to 0%.

Funding in the native token

Users with an open long or short order need to ensure that they have a sufficient amount of the native token on offer to meet their order commitment as the price feed shifts. If at some point they do not, then the order is cancelled from the queue. To establish an order, longs and shorts will need to specify how much of the native token they will commit to the order. For longs any surplus will be returned when the order is filled.

The Bill Creation Market

Basic properties

-   there is a range of bill series available at different expiry dates
-   all price quotes, purchases and sales of bill tokens occur against units of the currency token
-   the settlement of each bill token is one unit of the currency
-   the price at which a bill token trades in the market relative to a unit of the currency determines the yield to expiry (price and yield are interchangeable, and either can be expressed for users)

Expiries

A range of expiries can be set up to an arbitrarily long term, provided there is sufficient demand in the far-dated series. Markets in expired bill series are replaced by markets in new longer-dated series.

Settlement

Each bill token is settled for one unit of the currency token at expiry. For longs the bill token is replaced by the currency token. For shorts, their short bill token is replaced by a short currency token.

Matching

Each Bill Creation Market (ie for each expiry) is made up of bids and offers for bill tokens. Quotations can be expressed as a price in terms of the currency token, or as a yield on the currency token, as these are interchangeable. Bidders for the bill token are queued from highest price to lowest price (lowest interest rate to highest interest rate). Sellers of the bill token are queued from lowest price to highest price (highest interest rate to lowest interest rate).

The buy side consists of standard buy orders plus short cover orders. The sell side consists of standard sell orders plus new short orders.

Bill supply is created when a standard buy order meets a new short order.  Bill supply is destroyed when a short cover order meets a new sell order.

[start edit 27 Apr]

One-block delay in leverage for shorts

As a direct result of enabling new bills to be created against currency, new bill creation requires conversion of the currency proceeds to the native token in the Currency Creation Market. A market order is automatically placed into the Currency Creation Market in the block following bill creation, to provide native token leverage for the bill short.

When a bill short needs to cover, they use currency to buy back and cancel bills. Alternatively, if there is a margin call, native token collateral is first converted to currency at market, and then used to buy back and cancel bills in the next block.

Other implementations are possible – see Implementation and Practical Considerations - Bill Market Structure.

[end edit 27 Apr]

Rolling

Both longs and shorts can roll their positions before expiry. This can be accomplished by exiting a position and then establishing a new position in the desired series. It may also be feasible in time to establish roll markets for this common practice, where long rolls can be matched against short rolls at a price spread, which reduces the number of transactions from two to one.

Short Accounts

Unlike the Currency Creation Market where each short position for a user has a separate interest offer (Short Obligation) and is separately collateralized, all shorts for a single user on a single bill token appears as a single collateralized account.

[starspirit]

[Whitepaper v1] – Yield Market System for Pegged Block-chain Currencies

*** START WHITEPAPER ***

1. Introduction

This (draft v1) whitepaper describes a modular yield-based system for implementing pegged currencies on a block-chain. It is a complete architecture in that it integrates currency and bill/bond markets in a single system.

Bills and bonds are traded in yield and price interchangeably. The primary effort behind this whitepaper has been in trying to design an at-call currency market that is quoted purely in yield, rather than price. This would allow all parties to trade at a common at-call interest rate, and allow more intuitive comparison to term positions within a broader yield curve structure.

Embarrassingly it began as some initial rough designs and built into a very long whitepaper, and I’ve not had a chance to present the basic ideas to the community. Of course there may be something terribly wrong with it all. Anyway, it’s time to find out and submit it to the community. At a minimum there will be some unique ideas that may get people thinking along some different lines.

This is a novel solution to the pegging problem in that competition amongst all parties is purely on yield. The current BitAssets approach in Bitshares mainly competes on price, with the exception of short orders placed at the peg. Whether the optimal yield-based system ultimately proves better than an optimal price-based system is yet to be determined, as a fuller architecture for an optimal price-based system is still evolving currently within BitShares. Along with presenting this whitepaper on a yield-based approach, I challenge the community to think about the most complete price-based architecture (including integration with bond markets) so that we may make a good comparison. I’m happy if ideas are borrowed, that’s the point of sharing. This whitepaper itself may also be further refined.

The benefits of a pure yield-based approach are anticipated to be:

-   Instant exchange of the currency token for the native token at the peg
-   Maximum possible pegging of exchange prices in external markets
-   Improved market-making, arbitrage, and liquidity
-   A range of lending and borrowing terms to meet a wider range of user preferences
-   Market resilience to supply-demand mismatches and shocks
-   A modular market structure with a simply defined matching algorithm in each market
-   A more stable foundation for other financial services to build upon

Traditional money markets make use of an interest rate structure (or yield curve) that equilibrates supply and demand at varying durations. Flexible changes in the shape, level and steepness of yield curves allows the market to absorb changes in preferences and eliminates the need for rapid changes in the supply of base money.

This whitepaper seeks to define a similar structure that can be used for pegged currencies on a block-chain. It proposes consistent yield-based competition for a number of critical markets that must be economically linked to provide the ideal properties for a pegged currency system.

Bytemaster delivered a number of original insights on pegged block-chain assets:

-   they could be fully collateralized by the native token of the block-chain to eliminate counterparty risk,
-   they could be issued by parties that would like to leverage their exposure to the native token relative to the reference asset, and
-   issuers might be willing to pay interest to holders of the pegged asset for the ability to leverage, allowing yield on the currency.

Implementation since then has shown that it is possible to construct such a system that is capable of tracking the value of a reference asset. 

However, there are unresolved usability issues with today’s pegged currencies in Bitshares. Peg tightness and liquidity both need to be significantly improved, complexity and bug exposure removed, and greater user flexibility introduced across the term structure to satisfy a greater range of user preferences.

Key sources of complexity in the current system are:

(i)   that non-expiring fungible currency and expiring non-fungible shorts are wrapped in a single market, and

(ii)   matching prioritization uses price for some parties and interest for others.

[Start edit 27 Apr] The proposed BitAsset 3.0 eliminates (i) but turns matching prioritization to collateral for shorts. This eliminates yield, and treats currency as non-interest bearing cash. How this might fit in is explored in the Implementation section of the whitepaper. [End edit 27 Apr]

This proposal looks to alter the current implementation to a more modular and consistent approach with yield-based markets at a number of durations.

To achieve this, the currency system is decomposed into a number of markets that are economically linked.  These are

i)   a Currency Creation Market, in which new currency units are created and destroyed against the native token at the feed price, and

ii)   a Bill Creation Market (or Bond Market), in which new loans in the currency unit are created and destroyed at a range of terms.

Any one of these markets in isolation is not effective without the others. They are each critical linked components of the entire system. So the behaviors within each market are influenced by the whole.

Every currency and bill token (long) is essentially a claim to receive a market-determined yield. Every short on the currency and bill tokens is essentially an obligation to pay exactly that same rate to the longs. The markets in these tokens are each competitions in yield alone that continuously allocate the tokens to the most eager longs and the most eager shorts.

Together these markets form a yield curve from a term of zero (being the Currency Creation Market) to arbitrarily longer terms (in the Bill Creation Market). This consistency of a competition for yield leads to strong economic linkages right across the yield curve.



To accomplish this, in each of the markets by term, all longs, as well as all shorts, share a common interest rate. This ensures that all parties are treated equitably, and is the only way to ensure economic neutrality (no economic gain or loss) from simultaneously holding both sides of a market. While in the Bills Market the competition for yield leads to a floating price today for a specified future payment at expiry (equivalent to trading in zero coupon bonds), in the Currency Creation Market the price is fixed at the price feed, and the variable interest represents a continuous transfer from shorts to longs. This creates a need for some implementation differences between the Currency Creation Market and the Bill Creation Market.

The key challenge to the proposed system, at least in its purest form, is a heavy reliance on accurate and timely price feeds of the peg price into the system. However, as any pegged currency system must require owners to be able to redeem from issuers at a fair price, some such input is a critical requirement. This is an important challenge to be investigated, debated, and solved by the community. If not adequately solved, it could undermine the system proposed here [edit 23 Apr: in fact it will undermine any pegged currency system].

Pre-conditions

The following are pre-conditions to the required architecture:

(i)   The currency must be redeemable on the block-chain to eliminate counterparty risk,
(ii)   The currency must be backed by a pool of native tokens to meet redemptions, to avoid inflation of native tokens for redemptions
(iii)   Exchange of [edit] native tokens for creation or destruction of currency [end edit] must be facilitated at the feed price (near instantly) to ensure maximum pegging in all markets
(iv)   There needs to be a single floating variable to ensure supply and demand can equilibrate at the peg, the most recognized being interest
(v)   The interest rate must be determined by market forces between buyers and sellers, to ensure markets always clear (no shortage or surplus at the feed price)
(vi)   Markets at varying terms should be available, so that mismatches in term preferences between buyers and sellers can be priced along the yield curve, rather than stifling an isolated market.

[starspirit]

[Whitepaper v1] – Yield Market System for Pegged Block-chain Currencies

This (draft v1) whitepaper describes a modular yield-based system for implementing pegged currencies on a block-chain. It is a complete architecture in that it integrates currency and bill/bond markets in a single system.

Warning: Long post.